As depressed market valuations put equity funding beyond their reach, start-ups are increasingly turning to venture debt or loans to optimise their capital structure and preserve equity for future funding rounds, according to industry stakeholders.
Fintech StashFin, for instance, recently secured $100 million indebt through its registered non-banking financial company (NBFC) to facilitate onward lending. In 2022, Rebel Foods — which operates cloud kitchen brands like Fassos, Behrouz Biryani and Oven Story — raised $30 million, while quick grocery delivery service Zepto secured $20 million in venture debt.
Total venture debt disbursed in 2022 touched $800 million, from $538 million a year ago, even as venture capital declined by 30 per cent, according to venture debt company Stride. In fact, data from Bain and Company showed that venture capital funding softened in India in line with the global slowdown, with total deal value compressing to $25.7 billion from $38.5 billion during 2021-2022.
Although venture debt has increased, it is still about 5 per cent of the venture capital money that flows into the ecosystem every year, according to Apoorva Sharma, Managing Partner, Stride Ventures. “Therefore, even if there is significant room for growth, it can’t grow in silos as it is also a function of the venture capital money that comes into the ecosystem every year.”
She says venture debt as a percentage of venture capital should be 5-10 per cent ideally, adding, “Going beyond 10 per cent will prove to be extremely risky with such an asset class and should be avoided.”
The subdued funding environment is expected to last six to nine months more before getting better, she says.
It is the cautious approach of venture capital (VC) funds that is delaying the completion of equity rounds, according to BlackSoil, which manages an alternative credit platform comprising its NBFC and alternative investment fund (AIF), and has deployed $280 million across 140 deals, and has $120 million worth assets under management (AUM).
“Founders are increasingly turning to venture debt as a reliable and timely source of capital. This, in addition to subdued market valuations, has led to smaller equity rounds, prompting founders to seek ways to meet fundraising targets without diluting their ownership,” says Ankur Bansal, co-founder and director, Blacksoil Capital.
BlackSoil’s portfolio features investments in nine unicorns including Upstox, Udaan, Zetwerk, OYO Rooms, and Spinny, besides prominent companies like Curefoods, Blu-Smart, and the IPO-bound drone manufacturer ideaForge.
But debt comes with its pitfalls, such as higher overall cost of capital; financial risk as companies must generate cash flow to cover operational expenses and debt repayments; and covenants and restrictions imposed by debt agreements. Failure to meet these requirements leads to default or additional penalties, says Bansal.
Yet, given the current macro-environment, demand for venture debt is expected to grow 10x to $10 billion by 2030, he says.
However, start-ups are advised to avoid excessive leverage and debt trap. “Only those that lack leverage, no previous debt, and strategically need debt within their capital structure should opt for debt funding,” says Sharma.
According to a report by Boston Consulting Group and Trifecta Capital, 70 per cent of start-ups raise debt funding during the growth (series B and C) and expansion stages (series D and E onwards).
Fintech, B2B, consumer products and services, healthcare, logistics, agritech, software-as-a-service (SaaS), IoT, and electric mobility will need venture debt to meet upcoming operating and capex requirements, says Bansal.